Typical Terms in a Letter of Intent
There are numerous stages in any business purchase and sale transaction. It is a complex and time-consuming process. One of the earliest steps in the transaction process is establishing the fundamental terms of the deal. The typical method of doing so is through the letter of intent or term sheet. Commonly structured as a letter from one party to the other, the letter of intent (LOI) is the basis on which the remainder of the transaction rests, setting the key terms of the on which the transaction will be closed. Terms can change after execution of the LOI under certain circumstances, but, generally speaking, the core deal terms of the transaction are determined at this early stage. A letter of intent can include whatever deal terms the parties determine are appropriate. But addressing certain fundamental terms can help avoid conflict, delay and expense later.
Parties. Identify all parties to a deal from the outset. For instance, if the deal is between two entities, will the individual owners also be parties? If so, there will be personal liability for those owners, instead of entity liability only (absent a personal guaranty).
Deal Price. Depending on the nature of the business being transferred, this can be a simple lump sum payment, or it can be structured in any number of other ways. Will it be paid over time through a promissory note? Will there be an earnout structure? Will there be a working capital or other adjustment to be made post-closing?
Nature of Transfer. Again dependent on the nature of the business, and on the negotiated terms of the parties, a business sale is most typically accomplished through a merger, an asset sale or a stock or ownership interest sale. Each carries its only risks and rewards for each party, as well as varying tax implications. The structure of the deal, therefore, should be carefully considered and discussed with both legal and tax advisors before agreed upon.
Handling of Specific Liabilities and Assets. Generally a buyer will not want to take on any liabilities of the seller, while taking all the seller’s assets. Are there any liabilities that a buyer must have the seller take or that the seller will agree to assume? Any assets that the buyer wants to retain? Will accounts receivable transfer?
Post-Closing Terms. Do the parties intend the seller to serve in any role for the buyer after closing? If so, addressing compensation, term and termination now can save heartache later. For instance, will there be any guaranteed compensation or stock options involved?
Due Diligence. This is the period in which a buyer will review all operational, financial and business aspects of the seller and decide whether to continue with the deal. Setting an appropriate length of the due diligence period, and potentially providing for extensions, should be handled in the LOI. Consider whether one or more earnest money deposits are appropriate.
Setting the Closing Date. The parties will likely have varying ideas of an appropriate time frame for the transaction, with the seller pushing for sooner and the buyer wanting more time. Compromise will likely be needed, but neither party should rush the deal. Set a closing date that allows each party to cross all t’s and dot all i’s.
Restrictive Covenants. Discuss and agree upon non-compete, non-solicit and other restrictive covenant terms in the LOI phase. The parties will initially disagree on what terms are reasonable, but better to resolve this disagreement in this early phase than to risk delaying the deal later trying to resolve any disagreements.
The information herein is not legal advice and does not create an attorney/client relationship. The information is in the form of legal education and is intended to provide general information about the matter. The above is not, nor is it intended to be, legal advice. Consult your attorney with questions.